2 Shipbuilders Get Big Breaks In New Tax Bill

By EDMUND L. ANDREWS

Published: October 19, 2004

A little-noticed provision in the sweeping corporate tax bill that passed Congress last week would reduce taxes at two major military contractors by nearly $500 million over the next 10 years.

The provision, which primarily benefits General Dynamics and Northrop Grumman, would allow shipbuilders to postpone their taxes for years on profits from building ships and submarines for the Navy.

The new provision would benefit a handful of major shipyards, all owned by one of the two military conglomerates. They include the Bath Iron Works in Maine acquired by General Dynamics in 1995 and the company's Electric Boat division in Groton, Conn., as well as the Northrop-owned Newport News shipyard in Virginia.

The new tax break would reverse a rule that Congress imposed as part of the sweeping tax overhaul of 1986, when lawmakers in both parties were incensed that major military companies often paid no income taxes despite earning billions of dollars providing major weapons systems to the military.

Under the bill, Navy shipbuilders would be allowed to once again defer paying most federal income taxes on a project until the contract was completed. Because it takes about five years to build an aircraft carrier and three years to build a destroyer, the shipyards would be able to delay their tax bills for years, allowing more opportunity to offset taxes against future losses.

The measure's primary sponsor was Senator Olympia J. Snowe, Republican of Maine, who said she was determined to protect Bath Iron Works, one of her state's largest employers.

''This provision takes dramatic steps to remedy the inequity of how naval shipbuilders pay their taxes,'' Ms. Snowe said in a statement last week, just after House and Senate negotiators agreed to include the provision in a broader bill that would shower $140 billion in tax cuts across almost every segment of industry.

But critics said the provision would not create jobs, the stated intention of the tax bill, because employment at naval shipyards is determined almost entirely by federal spending on ships and submarines rather than by tax incentives.

''We're not going to buy any more war boats if we give them a tax incentive,'' said Robert S. McIntyre, director of Citizens for Tax Justice, a liberal research group here that has long scrutinized corporate tax practices. ''We're going to buy more boats if the government decides we need more boats.''

The shipbuilders' tax cut was typical of the furious scramble by lawmakers to include special provisions for their constituents in the bill. The final bill, which President Bush is expected to sign soon, includes tax breaks for oil companies, corn farmers, wine distributors and dozens of other highly specific industries.

General Dynamics and Northrop Grumman, which will also benefit from many of the new bill's general tax cuts, are heavy contributors to political campaigns. Since January 2003, General Dynamics' employees and political action committees have contributed $1.3 million, about 64 percent to Republicans. Northrop contributed $1.24 million, about 58 percent to Republicans.

Senator Snowe was among dozens of lawmakers whose support was needed to win final passage. She was also part of a bipartisan group that tried to tie a $10 billion buyout program for tobacco farmers, which is also part of the bill, to a new requirement that would allow the Food and Drug Administration to regulate cigarettes and other tobacco products.

House Republicans rejected that provision, but Ms. Snowe voted for the overall bill in part because it included the shipbuilding tax break that she had proposed.

She was hardly alone. Senator John Breaux, Democrat of Louisiana, opposed many parts of the overall bill but supported the shipbuilding tax break and numerous other tax cuts for oil companies that are big employers in his state.

Few if any lawmakers publicly objected to the shipbuilding provision, which was tiny in comparison with sweeping tax cuts, worth $42 billion over 10 years, on foreign profits of American multinationals.

The House and Senate passed the overall bill by overwhelming majorities.

Under current law, shipbuilders have to pay income taxes on long-term Navy contracts based on the percentage of work they have finished. When that requirement was imposed in 1986, lawmakers were furious that top military contractors were deferring almost all of their taxes, even though they were getting progress payments throughout the term of their contracts. According to Mr. McIntyre, the top 12 Pentagon suppliers paid an effective tax rate of only 6.3 percent in the early 1980's, and some companies often paid none.

General Dynamics and Northrop Grumman have both enjoyed big jumps in sales and profits from their shipbuilding divisions, which are dominated by Navy contracts, but tax payments at both companies during the same period declined.

At General Dynamics, which makes the Arleigh Burke class of Navy destroyers and Seawolf-class nuclear submarines, its marine division generated $2.5 billion in sales in the first six months of 2004, up 20 percent from the first half of 2003. Earnings in the marine business increased 39 percent, to $179 million, in the first six months of this year, compared with the first half of 2003.

Despite rising profits in all its divisions, General Dynamics' overall tax payments declined sharply in the first six months of this year, to $78 million from $119 million in the first half of 2003.

At Northrop Grumman, which produces aircraft carriers and a new generation of destroyers, profits in the shipbuilding division nearly doubled, to $186 million, in the first half of 2004 from $98 million in the first half of 2003. Northrop's overall tax payments fell to $291 million in the first half of 2004 from $112 million in the first half of 2003.

Cynthia Brown, president of the American Shipbuilding Association, said the new measure was necessary because shipbuilders often lose money early in a multiyear contract.

''A naval ship takes us anywhere from three and one half years to seven years to build, and an aircraft carrier can take as long as eight years,'' Ms. Brown said. Even though the government makes periodic ''progress payments'' as the work is completed, she said, those payments often fall short of costs in the beginning because the heaviest costs are at the start of a contract.

''This is not a tax cut,'' she said. ''This is a cash-flow issue.''

Photo: General Dynamics produces submarines at the Electric Boat shipyard in Groton, Conn. A tax measure passed by Congress allows shipbuilders to postpone payment of taxes on profits for years. (Photo by Carol Phelps/Associated Press)(pg. C12)

Correction: October 20, 2004, Wednesday
An article in Business Day yesterday about tax breaks for military contractors included in a bill passed by Congress misstated the amount of a tax payment by Northrop Grumman during the first half of 2003. It was $1.12 billion, not $112 million.